Diia.City is the Right Way to Achieve Economic Development in Ukraine

Ukraine is facing tough times today. However, all modern leading states have gone through many difficult periods in their history. That is why we sincerely hope that life will prevail in Ukraine and that the postponed demand for economic development and growth will quickly compensate for the losses suffered in recent years. As Winston Churchill used to say, while ruling the UK and a huge part of the world in difficult times: “Every crisis is an opportunity.”

For example, the Ukrainian state uncovers such opportunities in the digitalization of the economy. After all, in the modern world, technology and innovation play a key role, and representatives of tech companies are currently the most financially successful people.

That is why three years ago the Verkhovna Rada of Ukraine laid the foundations for a Ukrainian digital community by adopting the Law of Ukraine On Stimulating the Development of the Digital Economy in Ukraine, No. 1667-IX of 15 July 2021 (hereinafter — Law 1667-IX). This started a unique legal and tax space for IT companies in Ukraine called Diia.City.

1. Who can become Diia. City residents and why they chose this new legal regime

Diia.City offers tech companies a reduced tax burden, more flexible employment regulations, additional mechanisms to protect their intellectual assets, and easier attraction of foreign investment. Despite these obvious advantages, only a few players on the market rushed in to taste the new system at the beginning.

Nevertheless, since the first Diia.City residents registered only in February 2022, the number of residents had reached the 1000 mark in April 2024 the and this figure keeps increasing on a daily basis. As of June 2024, there are nearly 1,100 companies listed as Diia.City members.

At first, only IT product companies (Soft Serve, EPAM, MacPaw, etc.), showed interest in Diia.City. Moreover, they were the first big players who realized they could open a fresh company with a small group of employees and take a test drive without the need to go all in and risk the reputation of their long-time-grown legal entities.

The more that companies managed to enjoy and share their positive reviews of the new legal regime, the more newcomers became agitated and joined them in the pursuit of developing their business ideas. While certain business models could not be very profitable under standard taxation, the incentives provided by Diia.City appeared as a decent option to try one#s luck amidst russia’s full-scale war in Ukraine.

Diia.City has now become an attractive opportunity for companies from almost all types of economic activity eligible for this special regime.

The first group includes businesses directly connected with IT and TMT services, like cloud operators (GIGACLOUD) and game development companies (GameLoft, Gismart, Plarium, Playrix, etc.), which became interested in the safer options to attract various contractors and take care of IP protection.

Another group that grew rapidly within the auspices of Diia.City consists of neobanks and FinTech companies (Revolut, Monobank, EasyPay). These businesses, both foreign and Ukrainian-based, grow much faster than classic financial institutions and can often offer start-ups and investors more lucrative terms for financing their projects. FinTech residents were among the pioneers to show others the options that Diia.City can offer to other companies.

The IT departments of such large and important Ukrainian companies like Nova Poshta and Rozetka have also joined the system. In general terms, retail is not listed in those activities permitted for Diia.City residents, but it’s possible to separate the IT sector into a single legal entity that will only be responsible for IT services. This is a very convenient option for large networks that are not eligible for residency but which have, at the same time, particular branches that suit the requirements of Diia.City.

There are also many international companies with offices in Ukraine, like Samsung, Nokia, Visa, Lyft, Sixt, Snapp, ISSP, etc. They primarily use their residency for R&D centers, mostly employing Ukrainian experts.

Today, over 100 DefenseTech companies have become residents, which significantly enhances the quality and pace of their work. With the favorable conditions of Diia.City, these companies can produce more important items for our defense sector and keep their qualified experts working directly for Ukraine’s victory.

In February 2024, after 2 years of operation of the legal regime, owners and CEOs of resident companies shared their views and expectations regarding the legal regime. Thus, 76% of residents are well-established businesses and just 24% are start-ups.

Around 98% of residents are satisfied with the options offered by Diia.City. The main advantages are the ability to reinvest profits in business development (40.6%), reduced tax burden (26%), and transparency (8%). At the same time, just 2.1% are satisfied with the reduction of regulatory pressure. This indicates where the state needs to develop effective communication with businesses.

In addition, residents ask to eliminate legal collisions preventing equal taxation for all eligible companies, permit booking from mobilization for more contractors, expand Diia.City for a wider range of economic activities to attract more investments and develop more educational projects.

Ten of the largest Ukrainian tech companies (GIGACLOUD, Ajax Systems, Jooble, Monobank, Uklon, etc.) have created Diia City United. This union is aimed at strengthening the voice of the IT community in the dialogue with the state, addressing all the above-mentioned issues, and further involving the digital community in the recovery and development of Ukraine’s economy as a whole.

As we can see, the popularity of the Diia.City legal regime is growing steadily. This indicates that the state is offering favorable conditions for the development of tech business in Ukraine and provides for synergy with the business sector with a common goal in mind, namely to attain economic growth in Ukraine in the way that successful high-tech states have done.

2. Benefits of Diia.City for tech companies

Diia.City residents receive comprehensive benefits in all key aspects of business. The most important one is the legally binding promise that the state will not change conditions for businesses for the worse, compared to the initial options, for the next 25 years.

I. Reducing the tax burden

1) Payroll and benefits tax:

— 1.5% military tax is still the only tax with an equal amount for both residents and non-residents;

— 5% personal income tax is greatly reduced compared to 18% paid by non-residents;

— 22% social security fee is calculated only on the minimum wage.

2) Corporate tax:

— you can still choose a familiar corporate income tax with 18%;

— on the contrary, Diia.City offers a unique option of an exit capital tax that is two times less, at the 9% rate of the amount of dividends accrued.

Another essential benefit: you can switch your corporate tax model at any time.

Therefore, these features and lowered tax rates reduce risks for businesses that choose Diia.City compared to their usual business model, which uses individual entrepreneurs actually working as employees to minimize the tax burden.

II. Simplification of IT employment relations

As Diia.City residents, you can safely employ specialists using the reduced tax rates. This means that you have to maintain all the guarantees stipulated by labor legislation for such individuals.

This is where Diia.City can be helpful: the regime introduced a special form of employment called the GIG contract. This is a mixed version of an employment agreement and contract concluded with private entrepreneurs. It enables a firm to hire contractors as GIG specialists, selection of certain guarantees that a firm is willing to offer, preserving the freedom of the contract, and the setting of  remuneration without any linking to the wage amount stipulated by the state.

Law 1667-IX also helps to preserve important employer rights and the obligations of employees and gig-specialists. Finally, it legalized NDAs, NCAs, and NSAs, as some courts did not recognize these agreements and ruled against their provisions before Law 1667-IX came into force.

Now you can safely set a large, enforceable fine for those specialists who disclose confidential information or decide to accept a job offer from a firm’s competitor within a stipulated period. However, the rights of employees are also preserved: The Law stipulates the company to pay an additional fee for including such an option in the contract.

III. Stimulating investments in tech sectors of the economy

There are additional tax benefits offered for Diia.City residents:

1) 0% on the personal income of individuals as dividends accrued by a resident company, provided that they are paid no more than once in 2 years;

2) tax rebate on the amount of investments in Ukrainian start-ups enables a firm to pay personal income tax not on the entire amount of profit, but only on the excess amount of investments.

Diia.City also makes available certain venture capital investment instruments using English law.

1) Convertible loan: when a start-up is still young, it is very hard to assess its future value. Convertible loan agreements help to attract financing by stipulating the investor’s share in the future when the start-up can receive a market valuation.

2) Liquidation Preferences: if an investor allocates a huge amount of funds to a project, he/she can demand priority repayment of their investment when dividends are distributed or when a company is being liquidated.

4) Option & ESOP: investors receive an opportunity to increase their shares if a company succeeds and gains profits, so they can use this as leverage while investing in a start-up and drafting an investment agreement.

5) Warranties & Indemnities: both the owner and the investor have to disclose whether there are any additional obligations or reputational risks that can influence the company in the future. If some of them fail to identify these risks, this party will have to pay a large fine.

6) Liquidated Damages: the investor can hedge risks by evaluating them and setting a specific amount of compensation if liquidation ever happens. In this case, investors won’t have to prove that they considered such an event and the compensation cannot be reduced in a court.

IV. IP protection guarantees

There is also an important stipulation which states that any IP rights on any IP object created by a GIG specialist under a GIG contract belong by default to a Diia.City resident. The parties can set other terms in the contract.

3. Economic development = people + technology + Diia.City

We would like to draw special attention to the fact that there is always someone standing behind large companies, rapid financial results, and the state’s economic development. These are special people with a professional education — IT specialists, developers, experts, etc. If a business does not have enough of them, the owners can not run the company properly, it does not generate enough income, and less is paid in taxes.

In the last two years the residents of Diia.City paid over 12.5 billion UAH in taxes. Therefore, it is so important today to preserve these specialists and ensure that they can work freely and use their knowledge and skills to bring maximum benefit to companies.

Today, in light of increased mobilization, this issue is particularly acute for all sectors of the economy. Diia.City can become the very lifeline that supports tech companies in their intention to retain their specialists to follow their chosen path of economic development.

In early 2023, Diia.City’s resident status became one of the criteria for recognizing the company as critical to the Ukrainian economy and ensuring the livelihoods of the population during a special period. This status makes it possible to book employees liable for mobilization and protects the company from losing highly-qualified specialists. In addition, it also provides additional competitive advantages when companies hire new talent.

Unfortunately, this option works for booking only employees and does not apply to individual entrepreneurs and GIG specialists. However, Diia City United and other groups on Diia.City reform initiated active dialogue between Ukrainian tech businesses and the state. The next step is to expand the list of activities accepted by Diia.City and simplify the process of booking employees for all companies critical to the Ukrainian economy. This will unravel Diia.City as a profitable option for development for owners who weren’t able to select this legal regime before.

MK Legal Service has successfully supported several dozen companies in acquiring Diia.City residency, including one of the founders of Diia City United, GIGACLOUD, the cloud market leader that continues to implement ambitious plans for scaling and attracting investment in the USA, Canada, Saudi Arabia, UAE, Kazakhstan, Romania, Poland, and throughout the EU.

A lot of employees from various industries have received bookings from mobilization with the help of MK Legal Service and continue to work as usual. Therefore, if you intend to preserve and grow your business and help the economic development of our country during these veery hard times, do not hesitate to join the effective legal regime of Diia.City, which has already proven its value.